Invoice factoring allows a company to sell its accounts receivables to an outside party, but there are pros and cons to this approach. Here’s everything you need to know about invoice factoring.

Invoice factoring is a type of small business loan –  but it’s much different than other types of small business loans you’re probably used to. Invoice factoring is a type of accounts receivable financing where you sell unpaid customer invoices to a factoring company. 

The factoring company gets these invoices at a discount so they can collect the money due and make a profit, while you as the business owner get immediate cash (albeit, less cash).

The benefit to this is that you get “paid” for your invoices due right away. Meaning, you don’t need to wait on your customers to shore up on what they owe you.

This is very common with service-based businesses and B2Bs (where one company sells goods and services to another company). In many cases, these types of companies have large amounts of unpaid invoices and need cash sooner. And for a seasonal service business (think lawn care, pool care, etc.), invoice factoring has become a popular way to cover any cash flow issues that may arise.

So in this article, I will break down invoice factoring further and cover everything you could need to know about it. That way, you can determine whether factoring is the right solution for you and your business.

What is invoice factoring?

Invoice Factoring - Everything You Need To Know - What is invoice factoring?

Building off the point above, invoice factoring is a financial transaction when a company turns its debts into cash. The business sells its accounts receivables (invoices) to an outside party (a factor) at a slightly discounted price. The factor provides the company with the funding it needs to meet current cash demands.

Invoice factoring goes by other names, including accounts receivables factoring and accounts receivables financing. Whatever you call it, the transaction serves the same purpose – using existing debts to fix cash flow problems. Many factors will provide the seller with a cash advance on the same day.

There are also two varieties of invoice factoring – recourse and non-recourse.

Recourse vs. non-recourse factoring

You may or may not have to repay outstanding debts to your factor. It depends entirely on whether you secure recourse or non-recourse factoring. The example mentioned below about the fintech startup involves recourse factoring because the factor took a “recourse” to recover the remaining invoice funds.

Only the most reliable factoring companies can provide non-recourse factoring. The arrangement protects the seller from bankruptcy and insolvency. If you’re having trouble remembering the difference between the two, know that recourse factoring helps the lender and non-recourse favors the borrower.

How does invoice factoring work?

You don’t need an accounting degree to figure out invoice factoring. The process starts by offering goods or services to creditworthy customers. These people will repay their debts within the next month or two. The problem is that you need money now.

The second step involves contacting a factoring company. You can sell your unpaid invoices for a small fee, usually around 3%. Once the factor verifies that the accounts receivables are authentic, it will send you a cash advance. You can use that money at your discretion.

When your customers repay their debts, the payment won’t go to you. The terms of the invoice send the money directly to the factor. The factoring company pays the remainder of the outstanding balance back to your company.

An example:

Let’s say that you run a fintech startup. You have $15,000 in unpaid invoices, which your customers will repay at the end of the month. However, you need cash to buy hosting and equipment while paying your employees.

You started your fintech startup right out of college, so you don’t have excellent personal credit. Otherwise, you might visit your local bank or credit union for a business loan. You decide that you need the money urgently and contact a factoring company instead.

The factoring company buys your invoices for $14,550. (It pockets the $450 as part of its 3% factoring fee.) The company advances you $13,095 or 90% of the remaining balance within two or three business days. It will send you the remaining advance ($1,455) after the factor begins collecting the invoice (more on this below).

Your invoice factoring experience will vary depending on your creditworthiness, invoice amount, and total sales. While 3% serves as an average rate, companies will charge anywhere from 1% to 5%. If your customers do not repay the invoices, you may have to pay the factor for unpaid debts.

What factors are considered for invoice factoring?

To qualify for invoice factoring, there are a few things you need to have in order. To address the point above and the example I used, personal credit may or may not play a factor. In most cases when you seek credit for your business, the lender will look at your business credit

Only when your business has no credit (i.e., you’ve never gotten a loan, credit card, or other financing product) will your personal credit be considered. Now, there are always extenuating circumstances, but that’s the most common scenario.

According to Factor Finders, there are eight common things you need to have in order to qualify for invoice factoring:

  • A factoring application. You’ll need to fill out an application for factoring. This usually includes things like your business details (i.e., location, number) as well as your typical sales and invoicing volume.
  • An accounts receivable aging report. Also called the schedule, this report shows credit memos, notes, and unpaid invoices by date.
  • A copy of your Articles of Incorporation. This is what you received when your business was officially created. The Articles of Incorporation prove that your business is legitimate.
  • Invoices to factor. These are your unpaid invoices – the ones you want to sell to the factoring company.
  • Credit-worthy clients. Factoring companies want to see unpaid invoices from clients they are sure will pay them. Having unpaid invoices from big businesses with good credit and a good history increases your chances for invoice factoring.
  • A business bank account. Factoring companies will only deposit funds into a business bank account – not a personal one – and they will not give out cash. If they are offering either of these things, check into the credibility of the company. That said, you’ll need a business bank account to receive funds.
  • A tax ID number. This is your Social Security Number in most cases, but usually, they’ll want to see your business EIN – Employer Identification Number.
  • A form of personal identification. To identify yourself as the owner of the business.

How does invoice factoring differ from bank loans?

Invoice Factoring - Everything You Need To Know - How does invoice factoring differ from bank loans

Invoice factoring and bank loans serve the same general purpose. A small business agrees to a financial transaction with a lender in exchange for operating cash. While traditional bank loans are cut and dry, invoice factoring is technically not a loan at all.

Invoice factoring is a debt-free form of financing. You are selling your assets to a factor that compensates you with upfront cash. You don’t have any long-term obligations with the lender, instead of bank loans, which can take several years to repay.

Bank loans provide you with a lump sum of cash that you repay with interest. According to Experian, the average interest rate on personal loans is 9.41%, though some financial institutions charge as much as 36%. If you do not make payments on time, it will hurt your credit score. 

When you should use invoice factoring

Invoice factoring can be a great solution for those who qualify and have the right circumstances. That said, here’s when you should use invoice factoring:

You have a large number of unpaid invoices

Invoice factoring works best for covering cash flow issues, so if you have a large number of unpaid invoices, it can be a great solution for you. Factoring companies also want to see large amounts of unpaid invoices (not necessarily from a ton of different clients though) so the investment is worth it to them.

You have credit-worthy clients

If you have clients that have a history of paying on time (or even paying late, but consistently paying you) and have good business credit, invoice factoring can be a great solution. Remember that factoring companies want to work with clients who they expect to pay – they’re not a collections shop.

You need cash quickly

If you need cash quickly to help keep your business moving in a positive direction, invoice factoring provides one of the best solutions for this. Rather than putting debt on a credit card, using your personal credit, or taking out a cash advance or other quick-funding loan, invoice factoring can be a lower-cost option that is far more credible, yet still gets you cash almost instantly.

You routinely have big clients late with their payments

Working with a credible factoring company can actually be an excellent partnership. Remember that they focus on the credit of your clients, not you. So if you routinely have big clients that pay you late, but you need to be paid sooner, developing a consistent relationship with a good factoring company can be a huge asset to your business.

When you shouldn’t use invoice factoring

There are downsides to invoice factoring, though. So you might not want to use invoice factoring in these circumstances:

You’re desperate for cash

If you’re desperate for cash and just need something to keep your business afloat, odds are you have way bigger issues than a short-term cash-flow solution. While invoice factoring may help you right away, it won’t solve long-term business issues such as declining market share or a shrinking business overall.

You want the best possible rate

Invoice factoring focuses on speed. Part of the cost of that speed is a higher rate. So in many cases, you’ll pay more with invoice factoring than you would with traditional business lending. If you’re after the lowest rate possible instead of quick cash, look elsewhere.

You have needy or highly-sensitive clients

This is only a risk if you choose a factoring company that isn’t the most ethical or good with customers. In many cases, the factoring company will work with your clients directly – which may include phone, mail, or email correspondence. You do run the risk of the factoring company hurting your relationship with your best clients, so it’s best to pick a reputable company. 

Pros and cons of invoice factoring

Invoice Factoring - Everything You Need To Know - Pros and cons of invoice factoring


  • Ability to get cash quickly. Invoice factoring works best for businesses that need fast cash but can’t secure a traditional bank loan. The financial arrangement can bail companies out of a financial pinch when they need it most. Some factors have same-day cash advances so that you can receive funds in less than 24 hours. 
  • Faster than other options. Many small business owners gravitate towards invoice factoring because of its speed. It also has the added benefit of convenience. Invoice factoring often has a high approval rate because factors only care about your customer’s ability to repay their debts. That means you won’t have to worry about a hard credit check dinging your credit score.
  • Useful for new companies. Invoice factoring can help small or young companies that do not have collateral. If you’re a first-time business owner, you may find it challenging to collect unpaid invoices. Factoring companies allow you to outsource collections responsibility as the factors convert non-paying customers into paying ones. 
  • More personalized service. Invoice factoring clients can also take advantage of personalized service. Some companies will provide you with a dedicated case manager that offers industry expertise and works on your behalf to collect accounts receivable. These concierge services can make the entire factoring process smoother.


  • Can become expensive. If you’re apprehensive about fees, invoice factoring may not be right for you. The service can get costly quickly. Watch out for processing fees, late fees, application fees, and hidden fees on top of the 1% to 5% charge for the transaction.
  • Potential blowback from customers. Invoice factoring might give you pause due to the potential blowback from customers. The last thing you want is for a factoring company to hassle your patrons about unpaid invoices. If you agree to invoice factoring, make sure that the process is clear and fair to them.
  • Relies on customers’ credit. The arrangement requires you to depend on customers’ creditworthiness. If they default on a payment and you have resource invoice factoring, you’ll be on the hook for the remaining balance, which may derail your finances. You can mitigate this risk by financing some of your accounts receivables rather than all of them.

Invoice factoring vs. invoice financing

Invoice Factoring - Everything You Need To Know - Invoice factoring vs. invoice financing

I’ve already covered invoice factoring, so what the heck is invoice financing? The process, also known as invoice discounting, involves borrowing money against your outstanding invoices. A lender will give you 80% to 90% of the balance as a loan.

You can repay the factor after your customers repay you. The factor will charge fees plus interest to earn compensation. Your company still retains the responsibility of collecting all the existing accounts receivables that your customers owe.

Invoice financing more closely resembles a traditional bank loan. The more significant difference, though, is which party collects the unpaid invoices. Invoice financing requires your business to do it, while invoice factoring puts that responsibility on the factor (lender).

Invoice factoring tends to be more expensive than invoice financing because the borrower hands off responsibility for collecting unpaid debts. The process works best for companies that do not want to collect payments on their own. It also benefits organizations with outstanding balances over the next two to three months instead of immediate dues. 


Invoice factoring can be a useful tool, especially if you are short on cash. The service caters to small businesses in need of cash flow to solve pressing financial issues. If you find yourself needing invoice factoring month after month, though, you should 1) improve your collections process, 2) cut costs, and 3) generate revenue.

Invoice factoring provides a debt-free alternative to traditional bank loans. Make sure to exercise caution when arranging a lending agreement because some factors border on predatory lenders. 

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Chris Muller picture
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Chris has an MBA with a focus in advanced investments and has been writing about all things personal finance since 2015. He’s also built and run a digital marketing agency, focusing on content marketing, copywriting, and SEO, since 2016. You can connect with Chris on Twitter.